How the Debt Deal Sets Up Washington for a Bitter Tax Fight

Now that a compromise has been reached to raise the debt limit, there is a good chance that the political climate in Washington is going to get worse. And the reason can be found on Page 49 of the bill that President Obama signed into law on Tuesday: “On January 2, 2013, for fiscal year 2013, OMB shall calculate and the President shall order a sequestration, effective upon issuance and under the procedures set forth in section 253(f) … ” It’s what you might call a kicking-the-can provision.

In plain English, the 2013 date means that if Republicans and Democrats refuse to cut a deal later this year to reduce the 10-year budget by $1.5 trillion, the punishment, in the form of draconian cuts to defense and Medicare, will not take effect for more than a year — not until after the next election, on the first Wednesday of 2013. That gives both parties time to fail, in an environment in which they each have clear incentives to once again put off a deal.

Democrats have already been saying publicly that such a delay could play to their advantage because it will force the joining of two separate issues: the expiration of the Bush tax cuts, which also will occur on Jan. 2, 2013, and the issue of deficit reduction. White House aides have said publicly that they are willing to let the special committee, which has been designated to produce a new plan for cuts by November, fail if Republicans do not agree to increase tax revenue. Office of Management and Budget Director Jack Lew explained the strategy on MSNBC’s Hardball on Monday afternoon.

“We are now going to face a number of things coming together at the same time,” said Lew. “The special committee — if it reports and gets its job done, we’ll be fine. If it fails, and if the automatic spending cuts are scheduled to take effect, they would take effect Jan. 1, 2013, the same day that the Bush tax cuts expire. And I am telling you that these issues are going to be joined and there will not be a resolution that is not balanced.” Translation: If Republicans don’t give us more tax revenue, we will force new tax revenue after the next election by not extending the Bush tax cuts, effectively raising rates on the wealthy and the middle class.

Republicans know there will be a political cost to any bipartisan deal that raises revenue, giving them an incentive to put off a deal until after the next elections. If they give in to a tax increase by closing loopholes this year without a larger deal to extend the Bush tax cuts, they will compound their problem by giving Obama additional leverage. This suggests that the only solution is for the special committee to propose a larger tax-reform effort, which would lower top-line rates on businesses and individuals while increasing net revenue.

The question is whether Republicans will calculate a political advantage to cutting this deal before the next elections. If the past several weeks have shown anything, it is that Republicans risk deep division within their ranks whenever tax increases are considered, including the danger of drop-offs in fundraising and the threat of primary challenges. For many Republican members of Congress, cutting such a deal right after an election, especially one in which Republicans could gain power in Congress and win the White House, might be more palatable than doing it before an election.

And so the standoff that seized the country over the past year is likely to be an issue in the next election. “The election is going to have consequences, because it is going to determine what we do about deficit reduction,” one Democrat says of the 2012 election. Get ready for much more of the same.